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Please note: The Frank Talk articles listed below contain historical material. The data provided was current at the time of publication. For current information regarding any of the funds mentioned in these presentations, please visit the appropriate fund performance page.

Why We Invest in Royalty Companies

February 26, 2015

“Much of the gold mining industry is underwater and can’t make money with these prices. We’ve seen capital programs being significantly cut back, in terms of companies looking to expand and build new mines.”

“Those companies have been sufficiently scared enough that, even when gold prices do recover, they’re going to hold off on expansions because they might have lost the appetite to risk capital on new projects.”

This is where royalty companies come in.

As a refresher, royalty companies basically serve as specialized financiers that help fund cash-strapped miners’ exploration and production projects. In return, they receive either royalties on whatever the mine produces or what’s known as a “stream,” which is a commitment to an agreed-upon number of ounces of gold or other precious metal per year.

From an investors’ point of view, royalty companies just have a superior business model. I’ve discussed this on numerous occasions, most recently during this week’s Gold Game Film, which we shot in Fort Lauderdale following the 2015 Gold Stock Analyst Investor Day.

Attractive Risk/Reward Profile

There are several reasons why Ralph and I find these companies so attractive.

For one, they’ve typically remained well-diversified. Whereas any given mining company might own only one or two mines—which may or may not be operational—royalty companies can stay profitable by receiving regular streams of revenue from multiple sources. Toronto-based Silver Wheaton, the world’s largest precious metals streaming company, has secured the right to purchase silver at a very low fixed cost from 18 operating mines in North and South America and Europe.

Another reason why these companies have outperformed is because, simply put, they’re not the ones getting their hands dirty. Their only obligation is to lend capital. They don’t build the mine’s infrastructure; they’re not responsible for cost overruns or maintenance; they don’t experience capital cost inflation; and they don’t have dozens of miners and other personnel on their payrolls. Royalty companies, therefore, enjoy many of the upsides of being in the precious metals industry but face very few, if any, of the risks.

To elaborate on one of the points already made, these companies have extremely low overhead compared to miners. Silver Wheaton is run by 30 people at most, and yet it generates around $500 million in revenue. On average, that’s $16 million per employee! It’s very possibly the world’s most profitable company on a revenue-per-employee basis.

Other royalty companies that have been good to our precious metals funds are Royal Gold and Franco-Nevada. Both have huge cash flow, wide profit margins and pay dividends. Since Franco-Nevada went public in December 2007, it’s torn past both spot gold and most gold equity benchmarks.

As of now, royalty companies make up about 13 percent of USERX and 12 percent of UNWPX.

Diversify and Rebalance

As always, I recommend a 10-percent weighting in gold: 5 percent in gold jewelry or bullion, the other 5 percent in gold mining stocks. Remember to rebalance once a year.

“You might also get some additional benefits by rebalancing quarterly,” Ralph says. “That’s like playing chess with the market as opposed to rolling craps.”

In the meantime, look for the Shareholder Report, arriving soon in mailboxes all across the nation! Inside you’ll find articles not just on gold but also topics ranging from growth in India and Turkey to our Near-Term Tax Free Fund (NEARX), which has delivered 20 straight years of positive returns.

NEARX, in fact, is the focus of our next webcast, to take place next Wednesday, March 4. We hope you’ll join us!

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Gold, precious metals, and precious minerals funds may be susceptible to adverse economic, political or regulatory developments due to concentrating in a single theme. The prices of gold, precious metals, and precious minerals are subject to substantial price fluctuations over short periods of time and may be affected by unpredicted international monetary and political policies. We suggest investing no more than 5% to 10% of your portfolio in these sectors.

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There is no guarantee that the issuers of any securities will declare dividends in the future or that, if declared, will remain at current levels or increase over time.

The S&P/TSX Global Gold Index is an international benchmark tracking the world's leading gold companies with the intent to provide an investable representative index of publicly-traded international gold companies.

Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by clicking here or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Foreside Fund Services, LLC, Distributor. U.S. Global Investors is the investment adviser.

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Bond funds are subject to interest-rate risk; their value declines as interest rates rise. Tax-exempt income is federal income tax free. A portion of this income may be subject to state and local income taxes, and if applicable, may subject certain investors to the Alternative Minimum Tax as well. The Near-Term Tax Free Fund may invest up to 20% of its assets in securities that pay taxable interest. Income or fund distributions attributable to capital gains are usually subject to both state and federal income taxes. The tax free funds may be exposed to risks related to a concentration of investments in a particular state or geographic area. These investments present risks resulting from changes in economic conditions of the region or issuer.

Gold, precious metals, and precious minerals funds may be susceptible to adverse economic, political or regulatory developments due to concentrating in a single theme. The prices of gold, precious metals, and precious minerals are subject to substantial price fluctuations over short periods of time and may be affected by unpredicted international monetary and political policies. We suggest investing no more than 5% to 10% of your portfolio in these sectors.

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